The Latticework
Charlie Munger called it “elementary worldly wisdom” — a latticework of mental models borrowed from multiple disciplines: physics, biology, psychology, economics, mathematics.
Why multiple models? Because if you only have one or two, you will distort reality to fit them. The world is too complex for a single lens. Isolated facts are useless.
The goal is not to become an expert in every field. The goal is to collect the big ideas — the ones that do most of the explanatory work — and let them interact.
The Models That Matter
What follows is not an encyclopedia. These are the models that became load-bearing walls in The Infinite Investor — a book I wrote to map the mathematics of long-term wealth creation. It is available for free on this site.
Each model below includes a reference to the relevant chapter.
1. Power Law
In most domains, outcomes are not normally distributed. A tiny minority produces the vast majority of results.
Hendrik Bessembinder proved this for markets: 4% of stocks generate all net wealth since 1926. The other 96% collectively match Treasury bills. The median stock — not the average — fails to beat the risk-free rate.
This is not a bell curve. It is a Power Law: massive pile-up of losers on the left, thin middle, and a tiny spike of super-winners on the far right.
Implication: In a concentrated portfolio, the statistical probability of picking a long-term loser is overwhelming. The Index exists in the system to guarantee ownership of the 4% — including future giants not yet recognized.
→ Chapter I: The Lie of the Average
2. Volatility & Harvesting
A stock falls 50%. To return to even, it must rise 100%. The math is asymmetric.
This gap between arithmetic average and geometric (compound) return is the Volatility Tax — invisible on brokerage statements, but it erodes wealth with every swing. Two portfolios with identical average returns can produce wildly different outcomes. The one with lower volatility compounds faster.
Claude Shannon proved something counterintuitive: systematic rebalancing between cash and a volatile asset generates returns from volatility itself — without predicting direction. This is Shannon’s Demon: value extracted from oscillation.
The practical application is Harvesting. When an Amplifier spikes, profits are taken. Paper wealth (fragile) converts to real wealth (permanent). The capital gains tax paid is not a penalty — it is an insurance premium against reversal. You pay either the visible tax (capital gains) or the invisible tax (volatility drag). Choose the visible one.
→ Chapter I: The Invisible Tax / Chapter IV: Communicating Vessels / Chapter V: Harvesting Lens
3. Ergodicity & Survival
A system is ergodic when what one person experiences over time matches what the group experiences at one moment. Most of finance is non-ergodic: your path matters, ruin is possible, and averages lie.
“The market returns 10% historically” is an ensemble statement. It tells you nothing about your personal outcome — because your specific path might include a permanent loss from which you never recover.
Zero is an absorbing barrier. Once touched, the game ends. This is why Warren Buffett’s Rule #1 — “Never lose money” — is not folksy wisdom. It is a mathematical command.
Charlie Munger adds: “The first rule of compounding is to never interrupt it unnecessarily.” Compounding requires time. Time requires survival. The hierarchy is absolute: Survival first. Compounding second. Optimization never.
The structure that implements this is the Barbell — a Shield (Cash + Index) that guarantees survival, freeing a Sword (Selection + Amplifiers) to pursue aggressive growth. Neither alone is sufficient. Both together create a portfolio that is aggressive because it is protected.
James Carse distinguished finite games (played to win) from infinite games (played to keep playing). Investing is an infinite game. The goal is not to beat the market this quarter. The goal is to stay in the game long enough for compounding to work.
→ Chapter II: Ergodicity and Behavior / Chapter III: The Foundation / Chapter VIII: Finite to Infinite
4. The Vase Principle
A vase can be kept intact or shattered — but it cannot be made “more intact than intact.”
Behavior can destroy ergodicity but can never create it. The S&P 500 has maximum structural ergodicity — it literally cannot die. Investor behavior can destroy participation in that ergodicity (panic selling, timing attempts, over-leveraging), but behavior cannot improve upon it. The best possible outcome is capturing 100% of the ergodicity the asset naturally offers.
Most investors capture far less — not because they own bad assets, but because their behavior introduces non-ergodicity where none existed.
The optimization mindset — the belief that intervention improves outcomes — is a categorical error when applied to ergodic systems. Every “improvement” attempted is a bet that personal judgment exceeds the structural properties of the system.
The optimal strategy for the vase collector is to stop collecting behaviors and simply possess the vase.
→ Chapter II: The Vase Principle / Chapter V: Behavior Lens
5. Inversion
Charlie Munger’s signature method: instead of asking “How do I succeed?”, ask “What would guarantee failure?” Then avoid those things.
Applied to compounding, the question inverts from “How do I compound wealth?” to “What destroys compounding?”
The answers are simple:
- Interruption — selling a compounder resets the clock
- Permanent loss — capital destroyed with no recovery
- Total ruin — portfolio hits zero, game over
All three are irreversible. Therefore, the first law of compounding is not “maximize returns.” It is: do not interrupt, do not lose permanently, do not get destroyed.
→ Chapter III: The Inversion
6. Cash as Infinite Option
The investment industry calls uninvested capital “cash on the sidelines.” The framing reveals a bias — cash as spectator, not player.
This is dangerous.
Cash is not a dead asset. It is a perpetual call option with no expiration date — the only infinite option in an investor’s arsenal. It never expires, never decays, never depends on being right about timing.
The “cost” of cash is an illusion created by measuring returns in isolation. The true return of cash is not its yield. It is the IRR of the opportunities it allows you to seize. When the market crashes 40% and you deploy into a quality compounder at half price, your cash earned the Fat Pitch premium — not the money market rate.
Warren Buffett maintains massive cash positions not because he cannot find opportunities, but because cash buys the right to act when others cannot. In a prolonged bull market, as investors abandon cash to be fully invested, the relative value of your cash increases with each investor who surrenders theirs.
Cash is productive by existing. Its product is freedom.
→ Chapter IV: Bucket 1 — The Infinite Option
7. Duration
Duration measures how far into the future you must wait to receive the bulk of cash flows.
Short-duration assets return cash soon: dividends, buybacks, predictable near-term earnings. Their value is anchored in the present. They are less sensitive to interest rate changes but vulnerable to disruption.
Long-duration assets return cash later: reinvested earnings, future growth, optionality. Their value is anchored in the distant future. They are more sensitive to discount rate changes but capture exponential growth.
In the bucket system, this maps to:
- Bucket 3A (Stabilizers): Short duration. Berkshire, Walmart, Johnson & Johnson. Cash now.
- Bucket 3B (Growth Engines): Long duration. Microsoft, Google, emerging compounders. Cash later.
Peter Lynch’s classification — Stalwarts and Fast Growers — echoes this distinction. The framework here categorizes by portfolio function and temporal characteristics.
The short duration funds the long duration. The portfolio becomes self-financing across time.
Some exceptional companies — Berkshire Hathaway, Alphabet, Amazon — contain both durations internally. They generate massive current cash flows AND invest heavily in long-duration projects. These dual-duration companies do internally what the investor tries to do at the portfolio level.
→ Chapter IV: Bucket 3 / Chapter V: Duration Lens
8. Margin of Expansion
Value investors speak of “margin of safety” — buying below intrinsic value to protect against errors. This is defensive.
Growth investors need something different: margin of expansion — buying where both earnings AND the multiple have room to rise. This is offensive.
Thomas Phelps documented the mathematics of 100-baggers: $10,000 compounding at 26% annually becomes $1,000,000 in 20 years. But how does a stock deliver 26% for two decades?
It requires two engines firing simultaneously:
- Engine 1: Earnings growth — the company grows profits year after year
- Engine 2: Multiple expansion — the market pays more for each dollar of earnings
Neither engine alone produces extraordinary results. Both together transform a good investment into a life-changing one.
Margin of Expansion is the discipline that positions you to capture the second engine. A stock purchased at 40x earnings has no margin — the market has already priced in excellence. A stock purchased at 15-20x retains optionality.
Clayton Christensen’s research adds a filter: beware companies with beautiful metrics achieved by retreating upmarket and abandoning growth. High ROE from cost-cutting and capital return is not the same as high ROE from compounding reinvestment. One is a cash cow. The other is a compounder.
→ Chapter VI: Twin Engines / Margin of Expansion / The Christensen Filter